CRM: FBR Charts Path to $10B in Revenue, Margin Expansion

By Tiernan Ray

FBR Capital‘s David Hilal today pounds the table on shares of Salesforce.com (CRM), whose shares he rates Outperform, raising his price target from $54 to $66 and writing that “We remain confident salesforce.com can drive 25% or better growth while delivering margin expansion.”

Salesforce shares today are down $2.05, or almost 4%, at $50.11.

Investors are concerned, writes Hilal, that as the company approaches $4 billion in revenue, which it is expected to hit this year, it may not be able to continue growing at the same rate, with 32% revenue growth projected this year. Hilal conducted meetings between company management and investors last week, he writes.

Helped by the acquisition of ExactTarget this past July, and by new services such as call center automation, it’s possible the company could hit $10 billion in revenue in years to come:

In December 2012, we published a report exploring how salesforce.com could grow to $8 billion by FY17 with expectations for each of the four major Clouds (see “Four Years to $50 Billion”). Almost a year and an important acquisition later (ET), the new bogey has been raised to $10 billion, a mark we think the company can reach in FY18. We believe the company’s TAM has expanded significantly from last year, partly due to the ET acquisition and partly due to greater expected adoption of these newer technologies. Using industry estimates for sales automation, service and contact center automation, marketing automation, and platform-as-a-service, we believe salesforce.com’s TAM will grow to $40 billion by FY18. If we included non-core products such as Desk.com and Work.com, the opportunity would be even greater. Management showed confidence that this large addressable market will allow salesforce.com to sustain its high-growth profile. In fact, the company believes it can reach $10 billion of revenue without moving into any new end markets. We believe the company can reach this goal by continuing to outpace the market in SaaS CRM and ramping the other Clouds, which have already grown to be as large as some stand-alone cloud vendors.

Hilal also thinks recent hires to the sales team, including ex-Oracle (ORCL) execs, will boost the company’s ability to move beyond small and medium businesses to sell more to enterprise:

Its early days, salesforce.com focused its efforts on small and medium-sized businesses, and recently it has been moving upstream into the large enterprise. Today, its efforts are evenly focused on small, medium-sized, and enterprise-sized companies (“a third, a third, a third”). Conversely, enterprise has been Oracle’s bread and butter for the better part of two decades, and salesforce.com wanted to enhance its enterprise go-to-market capabilities by bringing over sales leadership that had experience guiding sales teams as a company grew from $5 billion in revenue to $35 billion in revenue. This drove the summer hirings of Keith Block, the former head of Oracle’s North America Sales and Consulting, and Anthony Fernicola, a former Oracle SVP. The two now serve as salesforce.com’s president and vice chairman and president, global enterprise sales, respectively. We believe this new sales leadership will further enhance the company’s ability to successfully penetrate the large enterprise.

Hilal thinks profit margin can expand next fiscal year:

Salesforce.com’s operating margin peaked in FY10 (CY09) at 16.4%, not coincidentally at the same time billings growth hit an all-time low (+19%). Given we were still squarely in the middle of the Great Recession, there were simply less opportunities to invest for growth so margin expanded as a result. However, the company pressed down on the investment pedal in FY11 as the IT spending environment improved. Operating margin has been flattish or declined in each year since, but billings growth has also been 30% or better in each of these years. While the company will continue to place investing for growth ahead of margin expansion, we believe it has reached a scale where it can grow 25% to 30% annually and still deliver at least modest margin expansion. In FY14, the company would likely have delivered margin expansion if not for the ExactTarget acquisition. With no major acquisitions planned for the next 12 to 18 months, margin expansion should return in FY15. The magnitude will ultimately be determined by the growth rate, as the former remains the primary focus. In years where revenue grows more than 30%, we believe expansion would likely be closer to 50 bps, and in a normal 25% to 30% growth environment, we believe expansion would range from 100 bps to 150 bps. We believe investors would be satisfied in both circumstances. We do not think investors are looking for significant margin expansion yet but would like to see some efficiency gains. Like in the past, we expect management to provide a first glance of revenue and possibly margin expectations for FY15 on the next (F3Q) earnings conference call at which time we should have more clarity.

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